Everybody needs to borrow money some time. Peer-to-peer lending is a good alternative if you don’t want to pay usurious rates from loan sharks, if you’ve been denied a loan by your local bank or credit union, or if you are just too embarrassed to ask someone you know for help. From $1,000 for an emergency medical bill to $15,000 to pay for an engagement ring, some reasons are more legit than others!
As an investor in P2P lending, it’s always a good idea to set parameters on what type of person you plan to lend to. As P2P lending is primarily going to replace my low risk CD income that’s coming due, I intend to focus on low risk borrowers with high ratings between C to AA. They’ll probably pay rates of 6.59% to 15% so I can make a 4-10% return. An important part of understanding a borrower’s risk profile is to therefore understand what they plan to borrow money for!
I highlight all the main reasons why people borrow money through peer-to-peer lending. These are actually selections for borrowers to choose from on Prosper.com. I bucket the reasons into four categories (Great, Good, Borderline, Suspect) and analyze each reason from a borrower’s point of view. As a potential borrower in P2P lending, you can then decide whether you want to go forward with borrowing based on my rationale. The same goes for lenders when selecting loans to fund.
GREAT REASONS TO BORROW VIA PEER-TO-PEER LENDING
Debt Consolidation – Debt consolidation is by far the best reason to borrow via P2P lending. If you have a loan shark charging you 20% interest a month, or if you have stubbornly high credit card debt at 29.99% a year, borrowing money through Prosper.com to consolidate your debt is a financially good idea.
Let’s say you’ve racked up $50,000 in credit card debt at a 29.99% annual interest. Your credit card company loves you, but you’re just falling farther and farther behind if you only pay the minimum $1,500 a month. Let’s say you have a job, a good profile, and decent credit rating of around 680. You can likely cut your interest expense down by 10-15%, thereby saving $5,000-$7,500 in interest expense alone. Lower interest expense will in turn help you pay off your debt faster. Meanwhile, the more reliable you are in paying off your debt, the better your profile, and the lower the rate you could get on Prosper.
Baby & Adoption Loans – I’m a big believer in adoption. The world has over 140 million orphans who could use some help! The government currently gives an adoption credit of around $12,150 per child. Sounds like a decent amount, but that’s a one time credit and raising kids can be expensive.
If the choice is between letting your baby suffer and borrowing money at a reasonable rate to survive, then clearly it’s better to borrow money. Investors will likely be much more sympathetic to baby & adoption reasons. As a borrower, please be honorable in your use of funds and spend the money on your baby or adoption.
Medical / Dental – Goodness forbid nothing major ever happens to us, but statistics show from long-term care insurance studies that one in five will have some sort of major medical issue. No matter how healthy you eat or how much you exercise, genetics do not discriminate between rich or poor, and accidents do happen.
Dental work is also somewhat of a crapshoot. I grew up wearing braces for a couple years as a kid. I also went to the orthodontist to also get all four wisdom teeth pulled as well as a couple random teeth that weren’t supposed to be there! Going to the orthodontist was routine torture, but I’m extremely glad my jaw and teeth are fine now. It might sound shallow, but crooked teeth and a major overbite may have lessened my chances of getting a job or having a good love life. Such dental expenses must have cost my parents over $3,000 dollars.
GOOD REASONS TO BORROW VIA P2P LENDING
Taxes – If you don’t pay your taxes, you incur penalties and interest. If you don’t pay your taxes long enough, the government will come after your other assets and make your life difficult. And if you never pay your taxes, you will go to jail! Taxes are inevitable and the government’s way of imprisoning us all. If for some reason you haven’t kept up with your taxes, borrowing money is often times the only way to go.
Business – I believe in the American dream, which is why I quit the corporate world at the age of 35 to work on my own business. I highly recommend everybody start a business at least on the side by starting their own website. Once you have your online platform, you have exposure to potentially 3 billion+ people in the world! I started Financial Samurai on the side in 2009, and it’s since grown to make more than my day job as an Executive Director at an investment bank, with 90% less work and 100% more fun! You can start your own website with Bluehost for less than $4/month and get a free domain name for a year.
Home Improvement – This one is borderline good and suspect for me. Many people took out Home Equity Lines Of Credit (HELOCs) during the housing bubble and went crazy. The bubble burst and these folks lost their shirts. If you live in an area where land and the price per square foot selling cost is high, then it makes sense to expand and remodel. For example, my area in San Francisco has an average selling price of around $800/sqft. I can do a high quality buildout for $300/sqft or less, meaning I’ll get a 160% return on my investment!
The only remodels I recommend are kitchens, bathrooms, and necessary infrastructure upgrades for security purposes. Getting new double-paned windows are also nice, but costly. Everything else, I’d be hesitant to borrow money. You will very rarely ever get more than 80 cents on the dollar back on your remodeling expenditure.
BORDERLINE REASONS TO BORROW VIA P2P LENDING
Auto – Unless your car is an absolute necessity to earn money and survive, borrowing money to buy a depreciating asset is not a good idea. I happily drive a 12 year old, $5,000 automobile, and girls still give me the time of day. If you already have a high auto loan, then paying off your auto loan with a lower interest rate loan through P2P lending is a good idea. I know it’s tempting to get a sweet ride (I bought 8 cars in 10 years myself), but if you’re spending more than 20% of your income on the value of your car, then I would focus on making more money first.
Motorcycle – I’m a fan of motorcycles and have my M1 license. They are cheaper, get great gas mileage, and can be parked anywhere. The problem is, they are also much riskier than driving a car. You can get a great motorcycle for under $5,000. Scooters are around $3,500 for example and those are used the world over for long mileages. Getting a loan to buy a motorcycle is better than getting a loan to buy a car simply for the fact that you’ll borrow less and spend less money to maintain your motorcycle. Just make sure to go to M1 school, not run yellow lights, look both ways, avoid weaving between cars, and not brake too heavily on turns!
RV – This could be good or this could be bad. RVs are not cheap, but if the RV is going to be your main home for an extended period of time, getting a Prosper loan is just like getting a mortgage, but you can’t write the interest off your income. Taking the great American roadtrip sounds like a blast!
Green Loans – This is a tricky one because it is a little vague. A green loan can range from buying enough trees to plant around your house, to starting an organic food eatery. Borrowing money for solar panel systems to heat your home is a noble cause, especially since many states provide credit to the homeowner. I’ve upgraded my heating system in Hawaii with solar panels and so far so good. You’ve got to really think about the returns aspect of your green loan first. I notice some borrowers using Green Loans and Adoption Loans as a way to gain sympathy from investors.
Cosmetic Procedures – When we look good, we feel good. I get it. But, beauty is only skin deep unless you need major orthodontic surgery like me as a kid! You’d best use the borrowed money to improve your education or communication skills rather than your looks. Eat healthier, eat less, and go exercise 3X a week are obvious low cost alternatives. Although, if you want to get into an industry which emphasizes looks, then borrowing for cosmetic procedures seems more appropriate.
SUSPECT REASONS TO BORROW MONEY VIA P2P LENDING
Boat – They say the two happiest moments of a boat owner’s life is when he gets the keys and returns the keys. Getting a boat is a true luxury. Maintenance costs are high depending on the size of the boat and you’ve got to pay a monthly docking fee if you live in a big city by the water.
Vacation – Everybody deserves a nice vacation. But, if you need to borrow money to go on vacation, consider a staycation instead. Vacations usually last two weeks or less, while your debt repayments could last months or years. Focus on doing fun things locally like hiking, biking, exploring free museums and parks during the weekdays and so forth. You’ll surprise yourself.
Engagement Ring Financing – You probably don’t want to start your marriage off with debt, or more debt. If your bride to be loves you, she’ll understand if you can’t get that big rock she’s always wanted. Instead, consider getting her a diamond alternative ring, and tell her that as soon as you make enough money, you’ll “upgrade” her wedding ring to something else. She should be touched with your transparency and intent. If she’s not, reconsider your proposal!
Wedding Loans – The average American cost of $25,000 is somewhat absurd given the median household income is around $50,000. I guess if you guys and both sets of parents pitch in, that’s “only” $8,350 each for one day worth of happiness, but still. $8,350 is a lot! Think about all the better things you can use $25,000 on: paying off student loans, a downpayment, travel, a kid’s education and more. A wedding is special. I don’t think folks should borrow more than $5,000.
BORROW MONEY RESPONSIBLY AND WITH GOOD FAITH
Borrowing money via P2P lending is best for those who want to lower their existing interest rates through consolidation. Thanks to the economic downturn, many people have been shutout from commercial bank borrowing despite being good people. P2P lending offers a second chance for millions of folks to get back on track. For P2P investors, we have a chance to increase our returns in this pitiful low interest rate environment while doing some good at the same time.
Borrowing money via P2P lending at ~6.5%-10% is way cheaper than borrowing with a credit card which often charges well over 15-20%. Debt consolidation via P2P lending is also a smart move. Just remember that if you borrow money, you must pay your lender back.
If you want to invest in the notes, you can sign up with LendingClub.
Wealth Building Recommendation
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About the Author: Sam began investing his own money ever since he first opened a Charles Schwab brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college on Wall Street. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 35 largely due to his investments that now generate over six figures a year in passive income. Sam now spends his time playing tennis, spending time with family, and writing online to help others achieve financial freedom.